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May 31, 2014

What is worse than losing 100% on a stock ? It’s missing
a 10 bagger !

What’s worse than missing a 10 bagger ? It missing a 10
bagger which you identified and decided to take no action inspite of knowing
about the company. Now you must be thinking – that’s quite dumb ! In a way it
is, but as always the story is more nuanced than just being dumb.

So what’s the name of this mystery company ?

Let me give some more hints J ..I wrote about it in July
2010 when it was selling for around 80 Crs market cap. It now sells at around
1400 crores. That’s a 20 bagger excluding dividends during a period where the
market has gone nowhere.

I won’t tease you any more ….the company name is Mayur uniquoters!
See the post here
.

Now I can assign this to bad luck and move on. However I
have never operated this way – I want to dissect each failure – failure of
losing money or failure missing out on a 10+ bagger.

How did I miss it?

I wrote about this company in July 2010 when it was a
micro cap and started a small position in the company. I was comfortable with
the financial performance of the company, but was concerned with a corporate
governance issue – issue of warrants to the promoter at below market price,
when the company did not really need the extra capital.

As the stock price rose, I lost interest in the company
and sold my small position as I was not comfortable with the corporate
governance issue. In hindsight, I do not fault myself for this decision – it
was the right thing to do based on the facts known to me at that point

The downside of labeling

So where did I really go wrong? As I look back, I can
attribute the failure to a label I attached to the company. I was not
comfortable with the management and attached the label of ‘poor corporate
governance’ to the company.

After I sold my position in 2010, I continued to track
the company and could clearly see the good performance. Inspite of the facts, I
refused to change the label and remain locked to an existing view although the
management did not show any new governance issues.

First conclusion or confirmation bias

The other name for this locking is called the first
conclusion bias (read here).
Once I had reached a conclusion I refused to change it, inspite of evidence to
the contrary. It is only after the evidence became too obvious to ignore that I
have revisited my conclusion and realized the flaw in my thinking

The illusion of high valuation

If mayor uniquoters was an isolated example, it would
have been comforting to ‘label’ it as an aberration and move on. However there
are a few more examples (atleast ones which are obvious to me).

Let me give another example and the back story behind
missing the multi-bagger

Hawkins cooker: This stock was pointed out to me in 2010
when the company was selling at a PE of around 15. The company was and is easy
to understand, has great economics and a wonderful management. So if such a
company was presented to me on a platter , why did I ignore it ? The single
word for that is valuations – The Company was selling at a PE of 15+ which in
my mind was expensive.

I started off my investing life with high quality
companies such as asian paints and Pidilite selling at reasonable valuations
(15-18 times earnings) and slowly graduated to graham style low PE stocks (the
reverse of most people). Over time, I got locked into a mental model where I
started equating a low PE with an attractively priced stock and a high PE with
an expensive stock.

The above thought process holds true in isolation, but it
is important to consider the PE ratio in context of business quality. A
business with weak economics is a bad stock even if it has a low PE and an
exceptional business with a moderately high PE can still be a great stock. I
have been aware of this fact, but still had to relearn this important concept
all over again

How to change your mind ?

It would be safe to assume that if you are presented
‘data’ which contradicts your assumptions, you will change your prior
conclusions ? Atleast not in my case !

Let me point to two extreme example –

Ajanta pharma has been a multi-bagger since it was pointed
out to me by a very smart investor – Hitesh. I still have the email in which he
shared the idea with me in 2011. At that time, I was not comfortable with
pharma companies and thought that I could not judge Ajanta’s future prospects
accurately.

That’s a reasonable argument and can be a plausible
reason, but for the fact that this idea was posted
on the website – valuepickr by Hitesh and donald. This website is run by
Donald Francis and it has a lot of good investors who write regularly on it.
The good thing about this forum is that Donald, Hitesh and ayush have
encouraged a long term investing mindset with a focus on the process of
investing. I am not praising the website due to any vested interest (I don’t
have any), but think that one should read through the analysis on some of the
picks made by the team

I personally follow this site and occasionally post on it
too. Ajanta
pharma and Mayur
uniquoters are two such ideas which were posted on this site and analyzed
in a lot detail. I have been following these companies over the last few years
and inspite of over whelming evidence did not take the plunge

So much for changing my mind based on evidence!

How to change ?

The first step in fixing a blind spot is recognizing one.
Now that I have recognized multiple biases in my case, I have started focusing
on the following points in my investment process

-Do not equate a high PE with expensive. Analyze
the business in detail and determine if the company can still double in 3 years
at current or slightly lower valuations

-Focus on quality before valuations

-Constantly question my own conclusions. I
have started doing this after each quarterly result – does the company match
the original thesis (positive or negative)? Do I have access to some new
non-quantitative information which should prompt me to revise my original
thesis ?

I have already made changes in my stock picks in the
recent past and the initial results are good. In summary I think there is a lot
of value in analyzing the success of other people – not to be envious of them, but to reverse
engineer it and improve your own process.

Ps: if you guys have some stock tips, do send it my way.
I will have a more open mind on it now J

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Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please contact a certified investment adviser for your investment decisions. Please read disclaimer towards the end of blog.

Rohit, I have also missed out many such opportunities and it is part of the game. To name a few invested in alembic pharma when it has price of 35 and booked out at around 70. Invested in satyam for around 15 and again on 58 and booked out at around 103. Invested in Be ml recently at around 170 and sold out at 150. I was reading a article which says during 1990s, among TVS, bajaj and hero by looking at management quality, product protofolios, return ratio is etc TVS was best followed by bajaj which is struglling due to preference for motorcycle than scooters and hero has lots of management and ethics related issues but in next 20 years hero, bajaj in that order has created most shareholders return.

How do you rate Cera in the latter category (that have run up multi-fold but can still smartly move up over next 2 years)There is buzz on these sanitary stocks and that may continue on the back of business growth

hi anon missing some multi-baggers is part of the game. however the reason for missing it should be that you cannot understand the business. however if you do understand the business and if the fundamentals and other factors improve, why not buy again.

for ex: although TVS was expected to do well, an investor after a few years could have seen that Bajaj and hero Honda were doing a better job. once could have exited tvs and redeployed money in these companies. it should not be a one time decision

yes I am still holding it after I saw the analysis by you.thank you.I kept on checking the track record of the company.fair value to sell was recommended but I was ok with valuation.you are right with illusion of high valuation.

Hi RohitRajastan Spinning and Weaving Mills-(RSWM) This is one stock that i have seen around Rs 120 and had a mouth watering 9% dividend yield. I gave it a miss at it was in textile industry which was out of my circle of competence.

Piramal Enterprises is one more stock which I have bought and exited recently. Ajay Piramal's capital allocation skills and their foray into financial services and strong focus on formulations were the reasons for buying this stock. But i found it difficult in estimating its earnings and hence got out it.

Excellent post,you had written on similar lines but on opposite diretion on Crompton Greaves.........Black friday shopping time is going on in markets wherein everybody buys everything and anything for the very reason that others are buying and the it may not be available to them later on.............lets hope that Black Friday(shopping) does not turn into some black day for stock markets.

Excellent piece of advice. Happens. It happened in my portfolio with many stocks- Kavery seeds, poly medicure, La Opala, PI Industy, Acrysil- small positions taken which turned out so good in very short span of time that one could not raise stakes. But there are many beneficial small stakes- which plunged- Timbore Homes, Camson Bio, Kurturi, Neha International.... Taking a small stake in the beginning does save lot of capital. Buffet advised not to worry about omissions- just waiting for the perfect pitch.You are a delight to read. I learn a lot everytime I visit your blog. Thanks a Lot.

It is very honest of you to write this post. I think that honesty is a prerequisite to learning, and you don't survive in investing if you don't keep learning :-)

Now that we are talking about stocks that look expensive, I wanted to ask you if you have looked at Canfin homes. Looks like Canara Bank, like PNB Bank, is shifting its priority sector (upto 25 lacs) home loan business to its home loan comapny. Canfin has doubled in last few months now trading at PE of 10, still I can't think of situations where it can lose money in three years. This is considering that the current CEO has got extension of 2 more years. Any thoughts?

For education purpose can you write a blog on how to become a full time investor.I mean what should be the pre requirements one should achieve before becoming a full time investor,what should be the size of investment corpus vs annual expenses etc....

I too have faced a similar situation. In addition to this being a stock selection topic, to me it also seems to be a allocation framework topic. Let me explain the topic from allocation framework point of view. Suppose, my allocation framework is such that, am pre-decided about keeping only 10-20 positions. In that case, everytime, I want to add a new position on fully allocated PF, I have to axe something that i already hold (the least liked one). But this is little difficult psychologically (to put it mildly).Am thinking of a solution to the allocation problem on these lines.Keep a overall allocation of 10-15% of PF dedicated for names where I am interested but something is stopping me from being fully convinced and making a full allocation. This 10-15% of PF can be allocated to say 5-10-20 names (say 1/0.5 % each?)Over a period of time, if any of those businesses performs and i like it more, i start shifting allocation from my least liked idea in core holdings to this new one.While doing this, i observe that my reluctance goes down significantly compared to, if i had to completely axe a current holding to make way for the new one.This is something i picked up while discussing with some valuepickr's about turning many stones and gathering experience form it.Let me know what you think of this approach and if there are any significant negatives.

hi anuragCrompton greaves was a similar bias but in a different direction. there too I did not change my mind quickly enough when the evidence was there in front of me.ofcourse the loss was smaller than the missed gains which the multiples of the stock price

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Disclaimer

I do not provide investment advisory service via this Blog. The stocks discussed on the blog and each post are for educational and discussion purposes only and are not recommendations to buy or sell stocks.I may or may not have a position in the stocks discussed on this blog. For any investment decision, please contact a certified investment advisor.